Tapping Into Home Equity for Cash
Rising home prices are getting borrowers comfortable again with the idea of tapping their homes for cash.
Home-equity lines of credit and cash-out mortgage refinances, two products that let consumers spend the windfall of home ownership, are back in vogue with consumers. That reflects growing confidence and is a potential benefit to the U.S. economy as homeowners have more money to spend.
“If customers feel like their home values are stable or increasing, and if they feel like their job prospects are good—that they will have the ability to pay back a loan they take—then they will start to take out more home-equity lines,” said Mike Kinane, head of U.S. consumer-lending products at TD Bank. “That is what we are starting to see.”
Home-equity line originations rose 8% to nearly $46 billion in the second quarter, their highest level since 2008, according to credit-reporting firm Equifax. Borrowing via cash-out mortgage refinances hit $15 billion, up 6% from a year earlier, according to recent data from Freddie Mac.
The main engine driving demand: rising home prices. The median sale price of an existing home rose to $263,800 in June, the highest on record, up 40% from $187,900 at the start of 2014, according to the National Association of Realtors.
Banks insist the increased borrowing doesn’t herald a return to housing-bubble days when consumers came to view their homes as cash registers. Banks say they are being more cautious in how they make such loans and some add they are encouraging borrowers to tackle renovations or consolidate debt—uses that are considered investments rather than luxuries.
“We continue to watch what’s going on and the way it’s being done, but it’s much different from before the crisis,” said Tom Wind, head of U.S. Bancorp ’s home-mortgage division. Mr. Wind added that the bank expects this type of borrowing to keep rebounding because the equity in people’s homes is “meaningful and people want things like renovations.”
A home-equity line is similar to a credit card, where a borrower can spend as much or as little of the available credit as they wish—but with the house as collateral. In a cash-out refi, borrowers refinance an existing mortgage into a new one with a higher principal balance, putting cash in their pocket.
Marc Yu took out a home-equity line to buy an investment property, a house he now rents out at a profit. He has thought about paying off the line early, but instead decided to keep it open as long as interest rates stay relatively low.
“I wanted to use the equity” in the first house, rather than “it just sitting there,” said Mr. Yu, who works in digital forensics in the Atlanta area.
Low interest rates are another draw. For example, the average interest rate on a home-equity line is roughly 5.6%, according to Bankrate.com, a personal-finance website. Credit cards average 16.7%.
There are risks. A cash-out refi can extend the length of a mortgage and cost a borrower more in interest over the life of the loan. If home prices fall, a borrower who has tapped home equity can risk the mortgage being greater than the value of the home—a scenario that caught many in the financial crisis.
Those dangers aren’t lost on borrowers. Some bankers say wariness about the products have made home-equity lines and cash-out refis a tougher sell than they had expected. “Would I like to see it pick up more? Absolutely,” said TD’s Mr. Kinane.
Further increases in interest rates also could make both products less appealing. Many home-equity lines have rates that rise and fall with shorter-term borrowing benchmarks.
Rob Cash used a home-equity line to pay for upgrades on his Maryland home. But he paid it off as quickly as he could. He didn’t like having the debt hanging over his head, and didn’t want to get used to having the extra cash.
“It’s easy to…see it as more money,” said Mr. Cash, who works in construction, “when it’s just more debt.”
For banks, increased originations aren’t yet strong enough to stop continued declines in the overall level of outstanding home-equity-line debt. This is a hangover from the surge of such borrowing during the housing bubble. Lenders originated a combined $720 billion of home-equity-line credit in 2006 and 2007, according to Equifax data.
Borrowers typically only pay interest on these loans for the first 10 years. In subsequent years, both principal and interest is due.
Given that, borrowers often look to repay or refinance home-equity lines at or around the 10-year mark. Because of this, and the huge amount of such debt that was originated around a decade ago, new originations haven’t been enough to offset repayments.
The result: U.S. banks’ holdings of about $387 billion in revolving home-equity loans as of early August are down more than 35% from a peak of around $610 billion in early 2009, according to Federal Reserve data.
“Home-equity originations are up nicely, but continue to be outpaced by pay downs” of old lines, Bank of America Corp. finance chief Paul Donofrio told analysts in July on the firm’s second-quarter earnings call. That sentiment was echoed by other banks and means it could be another year or two before the drag from crisis-era loans fades.